Boomerang: Travels in the New Third World

by Michael Lewis

“Would you mind if we take a picture?” he asked my friend, after processing his passport application.

  “No problem,” said my friend.

  “Can we do it in front of the flag?” asked the official.

  My friend stared at the German flag. “What’s this for?” he asked.

  “Our website,” said the German official, then added that the government hoped to post the photo with a sign that read: This man is the descendant of Holocaust survivors and he has decided to return to Germany.

  COMMERZBANK WAS THE first private bank that the German government had to rescue during the financial crisis, with an injection of $25 billion, but that’s not why it had caught my attention. I’d been walking around Frankfurt one night with a German financier when I noticed the Commerzbank building on the skyline. There’s a law in Germany prohibiting buildings higher than twenty stories, but Frankfurt allows exceptions. The Commerzbank Tower is fifty-three stories high and unusually shaped: it resembles a giant throne. The top of the building, the arms of the throne, are more decorative than useful. The interesting thing, said the German financier, who visited often, is the glass room at the top, from which one looks down over Frankfurt. It is a men’s toilet. Commerzbank executives had taken him there to show him how, in full view of the world below, he could shit on Deutsche Bank.

  The Commerzbank chairman, Klaus-Peter Müller, actually works in Berlin, inside another very German kind of place. His office is attached to the side of the Brandenburg Gate. The Berlin Wall once ran, roughly speaking, right through the middle of it. One side of his building was once a field of fire for East German border guards, the other a backdrop for Ronald Reagan’s famous speech. (“Mr. Gorbachev, open this gate. Mr. Gorbachev, tear down this wall!”) From looking at it you would never guess any of this. “After the wall came down we were offered the chance to buy it back,” says Müller. “This building had been ours before the war. But the condition was that we had to put everything back exactly the way it was. It all had to be hand-fabricated.” He points out the seemingly antique brass doorknobs and the seemingly antique windows. Across Germany, in the past twenty years or so, town centers completely destroyed by bombs in World War II have been restored, stone by stone. The German government has agreed to pay some huge sum of money to rebuild the Berliner Schloss, the old Royal Palace that was leveled in the 1950s by the East German authorities, so that it will look exactly as it does in prewar photographs. If the trend continues, it will one day appear as if nothing terrible had ever happened in Germany, when everything terrible happened in it. “Do not ask me what it cost,” the bank chairman says, and laughs.

  He then offers me the same survey of German banking that I will hear from half a dozen others. German banks are not, like American banks, mainly private enterprises. Most are either explicitly state-backed or small savings co-ops. Commerzbank, Dresdner Bank, and Deutsche Bank, all founded in the 1870s, are the only three big private German banks. In 2009 Commerzbank bought Dresdner. Both turned out to be loaded with toxic assets, and so the merged bank required a government bailout. “We are not a proprietary trading nation,” says Müller, getting pretty quickly to the nub of Germany’s banking problems. German banking was never meant to be a high-stakes affair. Banking, done in the proper German fashion, is less a free enterprise than a utility. “Why should you pay twenty million to a thirty-two-year-old trader?” Müller asks himself. “He uses the office space, the IT, the business card with a first-class name on it. If I take the business card away from that guy he would probably sell hot dogs.” This man is the German equivalent of the head of Bank of America or Citigroup. And he is actively hostile to the idea that bankers should make huge sums of money.

  In the bargain, he tells me why the current financial crisis has so unsettled the German banker’s view of the financial universe. In the early 1970s, after he started at Commerzbank, the bank opened the first New York branch of any German bank, and he went to work in it. He mists up a bit when he tells stories about the Americans he did business with back then: in one story, an American investment banker who had inadvertently shut him out of a deal hunts him down and hands him an envelope with seventy-five grand in it, because he hadn’t meant for the German bank to get stiffed. “You have to understand,” he says emphatically, “this is where I get my view of Americans.” In the past few years, he adds, that view had changed. I sense a feeling of loss.

  “How much money did you lose in subprime?” I ask.

  “I don’t want to tell you,” he says.

  He laughs and then continues. “For forty years we didn’t lose a penny on anything with a triple-A rating,” he says. “We stopped building the portfolio in subprime in 2006. I had the idea that there was something wrong with your market. I did not have the idea that your market would completely collapse.” He pauses. “It has told something to me. I was in the belief that the best supervised of all banking systems was in New York. To me the Fed and the SEC were second to none. I did not believe that there would be e-mail traffic between investment bankers saying that they were selling . . .” He pauses again, and decides he shouldn’t say “shit.” “Dirt,” he says. “This is by far my biggest professional disappointment. I was in a much too positive way U.S.-biased. I had a set of beliefs about U.S. values.”

  The global financial system may exist to bring borrowers and lenders together, but, over the past few decades, it has become something else, too: a tool for maximizing the number of encounters between the strong and the weak, so that the one might exploit the other. Extremely smart traders inside Wall Street investment banks devise deeply unfair, diabolically complicated bets, and then send their sales forces out to scour the world for some idiot who will take the other side of those bets. During the boom years a wildly disproportionate number of those idiots were in Germany. As a reporter for Bloomberg News in Frankfurt named Aaron Kirchfeld put it to me, “You’d talk to a New York investment banker and they’d say, ‘No one is going to buy this crap. Oh. Wait. The Landesbanks will!’” When Morgan Stanley designed extremely complicated credit default swaps so they were all but certain to fail, so that their own proprietary traders could bet against them, the buyer was German. When Goldman Sachs helped the New York hedge fund manager John Paulson design a bond to bet against—a bond that Paulson hoped would fail—the buyer on the other side was a German bank called IKB. IKB, along with another famous fool at the Wall Street poker table called WestLB, was based in Düsseldorf—which is why, when you asked a smart Wall Street subprime mortgage bond trader circa June 2007 who was still buying his crap, he could say, simply, “Stupid Germans in Düsseldorf.”

  THE DRIVE FROM Berlin to Düsseldorf takes longer than it should. For long stretches the highway is choked with cars and trucks. A German traffic jam is a peculiar sight: no one honks, no one switches lanes searching for some small, illusory advantage, all trucks remain in the right-hand lane, where they are required to be. The spectacle of sparkling BMWs and Mercedes-Benzes in the left lane and immaculate trucks in a neat row in the right lane is almost a pleasure to watch. Because everyone in the jam obeys the rules, and believes that everyone else will obey them, too, the cars and trucks move as fast as they can, given the circumstances. But the pretty young German woman behind the wheel of our car doesn’t take any pleasure in it. Charlotte huffs and groans at the sight of brake lights stretching into the distance. “It’s what I hate more than anything in the world,” she says apologetically. “I hate being stuck in traffic.”

  She pulls from her bag the German translation of Alan Dundes’s book. I’d asked her about the title. There is a common German expression, she explains, that translates directly as “lick my ass.” To this hearty salutation the common German reply is, “You lick mine first.” The German version of Dundes is called You Lick Mine First. “Everyone will understand this title,” she says. “But this book, I don’t know about this.”

  The last time I’d been in Germany for more than a few days was when I was seventeen ye
ars old. I’d traveled across the country with two friends, a bike, and a German phrase book. In my head was a German love song taught to me by an American woman of German descent. So few people spoke English that it was better to assume they did not and deploy whatever German came to hand—which usually meant the love song. And so I assumed on this trip I would need an interpreter. I didn’t appreciate how much the Germans had been boning up on their English. The entire population seems to have taken a total-immersion Berlitz course. And on Planet Money, even in Germany, English is the official language. It’s the language used for all meetings inside the European Central Bank, for instance, even though the ECB is in Germany, and the only ECB country in which English is even arguably the native tongue is Ireland.

  Through a friend of a friend of a friend I’d landed Charlotte, a sweet-natured, keenly intelligent woman in her twenties who was also shockingly steely—how many sweet-natured young women can say “lick my ass” without blushing? She spoke seven languages, including Mandarin and Polish, and was finishing up her master’s in Intercultural Misunderstanding, which just has to be Europe’s next growth industry. By the time I realized I didn’t need her I’d already hired her, and so she had ceased to be my interpreter and become my driver. As my interpreter, she would have been ridiculously overqualified; as my chauffeur she is frankly preposterous. But she’d taken on the job with gusto, going so far as to hunt down an old German translation of Dundes’s little book.

  And it troubled her. For a start, she refused to believe there was such a thing as a German national character. “No one in my field believes this anymore,” she says. “How do you generalize about eighty million people? You can say they are all the same, but why would they be this way? My question about Germans’ being anally obsessed is how would this spread? Where would it come from?” Dundes himself actually made a stab at answering the question. He suggested that the unusual swaddling techniques employed by German mothers, which left babies stewing in their own filth for long periods of time, might be responsible for their energetic anality. Charlotte was not buying it. “I’ve never heard of this,” she says.

  But just then she spots something and brightens. “Look!” she says. “A German flag.” Sure enough, a flag flies over a small house in a distant village. You can spend days in Germany without seeing a flag. Germans aren’t allowed to cheer for their team the way other people do. That doesn’t mean they don’t want to, just that they must disguise what they are doing. “Patriotism,” she says, “is still taboo. It’s politically incorrect to say, ‘I’m proud to be German.’”

  The traffic eases, and we’re once again flying toward Düsseldorf. The highway looks brand-new, and she guns the rented BMW until the speedometer tops 210 kilometers per hour.

  “This is a really good road,” I say.

  “The Nazis built it,” she says. “That’s what people say about Hitler, when they get tired of saying the usual things. Well, at least he built good roads.”

  BACK IN FEBRUARY 2004 a financial writer in London named Nicholas Dunbar broke the story about some Germans in Düsseldorf, working inside a bank called IKB, who were up to something new. “The name IKB just kept coming up in London with bond salesmen,” says Dunbar. “It was like everybody’s secret cash cow.” Inside the big Wall Street firms there were people whose job it was, when the German customers from Düsseldorf came to London, to get a wad of cash and make sure the Germans got whatever they wanted.

  Dunbar’s piece appeared in Risk magazine and described how this obscure German bank was rapidly turning into Wall Street’s biggest customer. IKB had been created back in 1924 to securitize German war reparation payments to the Allies, morphed into a successful lender to midsized German companies, and was now morphing into something else. The bank was partially owned by a German state bank, but was not itself guaranteed by the German government. It was a private German financial enterprise, seemingly on the rise. And it had hired a man named Dirk Röthig, a German with some experience in the United States (he’d worked for State Street Bank), to do something new and interesting.

  With Röthig’s help IKB created, in effect, a bank, incorporated in Delaware and listed on the exchange in Dublin, Ireland, called Rhineland Funding. They didn’t call it a bank. If they had called it a bank, people might have asked why it was not regulated. They called it a “conduit,” a word that had the advantage that no one understood what it meant. Rhineland borrowed money for short periods of time by issuing something called commercial paper. They invested it in longer-term “structured credit,” which turned out to be a euphemism for bonds backed by American consumer loans. Many of the same Wall Street investment banks that raised the money for Rhineland (by selling the commercial paper for them) sold Rhineland the bonds backed by the American consumer loans. Rhineland’s profits came from the difference between the rate of interest it paid on the money it borrowed and the higher rate of interest it earned on the money it lent through its bond purchases. As IKB guaranteed the entire enterprise, Moody’s rating service gave Rhineland its highest rating, enabling Rhineland to borrow money cheaply.

  The Germans in Düsseldorf had one critical job: to advise this offshore vehicle they had created about which bonds it should buy. “We are one of the last to get our money out of Rhineland,” Röthig told Risk magazine, “but we’re so confident of our ability to advise it in the right way that we still make a profit.” Röthig further explained that IKB had invested in special tools to analyze the complicated bonds, called collateralized debt obligations (CDOs), that Wall Street was now peddling. “I would say it has proven a worthwhile investment because we have not faced a loss so far,” he said. In February 2004 all this seemed like a good idea—so good that lots of other German banks copied IKB, and either rented IKB’s conduit or set up their own offshore vehicles to buy subprime mortgage bonds. “It sounds like quite a profitable strategy,” the man from Moody’s who had awarded Rhineland’s commercial paper a triple-A rating told Risk magazine.

  I met Dirk Röthig for lunch at a restaurant in Düsseldorf, on a canal lined with busy shops. From their profitable strategy IKB has announced losses of roughly $15 billion, though their actual losses are probably greater, as German banks are slow to declare anything. Röthig viewed himself, with some justice, more as victim than perpetrator. “I left the bank in December 2005,” he says quickly, as he squeezes himself into a small booth. Then he explains.

  The idea for the offshore bank had been his. The German management at IKB had taken to it, as he put it, “like a baby takes to candy.” He’d created the bank when the market was paying higher returns to bondholders: Rhineland Funding was paid well for the risk it was taking. By the middle of 2005, with the financial markets refusing to see a cloud in the sky, the price of risk had collapsed: the returns on the bonds backed by American consumer loans had collapsed. Röthig says he went to his superiors and argued that, as they were being paid a lot less to take the risk of these bonds, IKB should look elsewhere for profits. “But they had a profit target and they wanted to meet it. To make the same profit with a lower risk spread they simply had to buy more,” he says. The management, he adds, did not want to hear his message. “I showed them the market was turning,” he says. “I was taking the candy away from the baby, instead of giving it. So I became the enemy.” When he left, others left with him, and the investment staff was reduced, but the investment activity boomed. “One-half the number of people with one-third the experience made twice the number of investments,” he says. “They were ordered to buy.”

  He goes on to describe what appeared to be a scrupulous and complicated investment strategy but was actually a mindless, rule-based investment strategy. IKB could “value a CDO down to the last basis point,” as one admiring observer told Risk magazine in 2004. But in this expertise was a kind of madness. “They would be really anal about, say, which subprime originator went into these CDOs,” says Nicholas Dunbar. “They’d say we won’t take loans from First Franklin but we w
ill take them from Countrywide. But it didn’t matter. They were arguing about bonds that would collapse from one hundred [par] down to two or three [percent of par]. In a sense they were right: they bought the bonds that went to three, rather than to two.” As long as the bonds offered up by the Wall Street firms abided by the rules specified by IKB’s experts, they got hoovered into the Rhineland Funding portfolio without further inspection. Yet the bonds were becoming radically more risky, because the loans that underpinned them were becoming crazier and crazier. After he left, Röthig explains, IKB had only five investment officers, each in his late twenties, with a couple of years’ experience: these were the people on the other end of the bets being handcrafted by Goldman Sachs for its own proprietary trading book, and by other big Wall Street firms for extremely clever hedge funds that wanted to bet against the market for subprime bonds. The IKB portfolio went from $10 billion in 2005 to $20 billion in 2007, Röthig says, “and it would have gotten bigger if they had had more time to buy. They were still buying when the market crashed. They were on their way to thirty billion dollars.”

  By the middle of 2007 every Wall Street firm, not just Goldman Sachs, realized that the subprime market was collapsing, and tried frantically to get out of their positions. The last buyers in the entire world, several people on Wall Street have told me, were these willfully oblivious Germans. That is, the only thing that stopped IKB from losing even more than $15 billion on U.S. subprime loans was that the market ceased to function. Nothing that happened—no fact, no piece of data—was going to alter their approach to investing money.

  On the surface the IKB’s German bond traders resembled the reckless traders who made similarly stupid bets for Citigroup and Merrill Lynch and Morgan Stanley. Beneath it they were playing an entirely different game. The American bond traders may have sunk their firms by turning a blind eye to the risks in the subprime bond market, but they made a fortune for themselves in the bargain, and have for the most part never been called to account. They were paid to put their firms in jeopardy, and so it is hard to know whether they did it intentionally or not. The German bond traders, on the other hand, had been paid roughly one hundred thousand dollars a year, with, at most, another fifty-thousand-dollar bonus. In general, German bankers were paid peanuts to run the risk that sank their banks, which strongly suggests that they really didn’t know what they were doing. But—and here is the strange thing—unlike their American counterparts, they are being treated by the German public as crooks. The former CEO of IKB, Stefan Ortseifen, was given a jail term (since suspended) and has been asked by the bank to return his salary: 805 thousand euros.